Community Reinvestment Act
DOES EUROPE NEED A CRA? This series of articles aims to answer the question: does Europe need a Community Reinvestment Act and more specifically what could we in Europe learn from the US experience in the implementation of such legislation. The first article looks at the American experience and is based on published materials and a field visit by the UK based Community Development Finance Association in 2004. The second article will look at the issues for Europe in adopting such an approach. The CRA was passed into law by the United States Congress in 1977. It built on the 1975 Home Mortgage Disclosure Act which Jan Evers has described as ‘Draconian’ and which created a source of data against which the lending of banks for home lending and enterprise could be assessed in communities. The purpose of the act was to make illegal the practice of discrimination by banks on a neighbourhood or geographic basis. “The Community Reinvestment Act is intended to encourage depository institutions to help meet the credit needs of the communities in which they operate, including low- and moderate-income neighborhoods, consistent with safe and sound banking operations The driver for both acts had been mortgage ‘red lining’ whereby banks or other lenders literally drew a red line around areas on the map that were seen as risky for home mortgage loans. Any application from within the area was normally refused. In practice these redlined areas were low income neighbourhoods containing high proportions of Black and Hispanic residents. CRA was responding to a well researched and documented problem of under investment by banks in minority neighbourhoods. In its initial format the act was something of a paper tiger. Although the act was well meaning it lacked teeth. In particular the data on lending by individual banks in specific areas remained confidential within the banking sector and was not available to outside researchers or activists. It took the reform in 1994 by the newly elected Clinton presidency to open up the debate by requiring public disclosure of bank lending by each bank. This article will focus on the post 1995 period when the act has been more effective. How the Act Works The CRA requires that each insured depository institution's record in helping meet the credit needs of its entire community be evaluated periodically. This is carried out every two to three years by one of the five federal agencies that are responsible for supervising deposit-taking institutions. That record is taken into account in considering an institution's application for deposit facilities, including mergers and acquisitions. Banks therefore have something to lose by scoring badly in their examinations. A merger or takeover could be delayed or even prevented. Since 1994 there have been three performance tests for lending, investment and services for large banks (defined as those with assets of over $250 million). Smaller banks (defined as those with assets less than $250million) are evaluated under a streamlined procedure and in particular they do not need to report on the number and extent of loans that they make in the defined areas. For the lending test the examiners consider * The number and dollar amount of loans made in and outside the assessment area * The Geographic distribution and dispersion between neighbourhoods * The Characteristics of the borrower Community Development Lending - Innovative and flexible lending practices For the service test examiners consider: * The history of opening and closing branches - income level of neighborhood * Overall effectiveness of the retail delivery systems * Extent and Innovativeness of Community Development Services – e.g. counseling * Range of services, are they tailored to that neighborhood Alternative methods for delivery of services – micro-enterprises, CDFIs, etc. For the investment test examiners consider: * Investment related to Community Development * Deposits/Grants to groups in assessment area Performance against each of the three tests is evaluated on a four point scale from Outstanding, through Satisfactory and ‘Needs to Improve’ to ‘substantial non-compliance’. These findings together with the evidence and argument to support the findings are published. The Summary Report on the Far East National Bank CRA Rating: This institution is rated Needs to Improve. Performance Levels: * Lending Test: “Needs to Improve” An inadequate lending volume * Investment Test: “Low Satisfactory” An adequate volume of investments, grants, and donations that meet a variety of needs, primarily in the Los Angeles assessment area, but no direct investments in other assessment areas * Service Test: “Low Satisfactory” Delivery systems distribute an adequate level of banking and community development services to the assessment areas. For the purposes of the act community development is defined as Affordable housing (including multifamily rental housing) for low- and moderate-income individuals; *Community services targeted to low- and moderate-income individuals; * Activities that promote economic development by financing small businesses and farms; * Activities that revitalize or stabilize low- or moderate-income geographies. The type of lending activity that has been generated under ‘Community Development includes: Loans for affordable housing rehabilitation and construction, aimed at low and moderate income people and loans to not-for-profit organizations serving primarily low and moderate income housing or other community development needs What the act does not cover Although to European eyes the act is an extraordinary piece of legislation, it does not cover large parts of the credit industry many of which have become more important since the CRA was enacted. Because the act only covers deposit taking banks it has no remit to regulate non bank financial operations including credit cards, doorstep lending, insurance, hire purchase etc. The way that the act focuses on geographic ‘fairness’ has meant that relatively little attention is paid to the performance of the banks in lending to specific groups that may face problems in obtaining credit. Recent research has indicated that women pay more for mortgages than men and may have greater difficulties to obtain a loan. The act does not require ethnic monitoring or examine the lending performance to other special groups such as people with disabilities, ex-offenders or young people. Despite these weaknesses the strength of the act is in the disclosure of data. This empowerment factor – combined with the level of detail within the data set has made it possible to examine spatial biases within the lending operation. There are two key aspects of the data collected. First is the small size of census tract districts that are used to report the bank data and enable the spatial lending performance to be compared with socio-economic variables available at the same spatial scale. If larger spatial units are used the averaging effect makes the data less useful. Secondly the data on individual banks allows comparative performance to be measured. The map below shows lending in Detroit by Census tract. In the map the dots show the loans while the depth of colour indicates the concentration of minority populations It appears from the map that some minority districts have high levels of sub prime lending while others do not. The point is that it is possible to gain an instant impression of the spatial distribution of lending activity in Detroit without knowing anything about the city. No equivalent map of bank lending activity for any city in Western Europe has ever been produced. CRA results and impacts The impact of the CRA is in two main areas. First there has been a dramatic increase in lending to low and moderate income borrowers that probably would not have occurred without CRA. This dimension is the most important result of the act. Home mortgage lending to black and ethnic minority groups has risen considerably in ten years of CRA activity. Over the decade Hispanic loans went up by 195.8% and black loans by 79.5%. In contrast loans to white borrowers only increased by 29.6%. Similarly lending to low and moderate income households went up at nearly double the rate (90.6%) of loans to middle income households (50.4%). The impact of these loans has been impressive. Minority home ownership rates have risen by 200% in the past decade. Secondly the CRA has encouraged an extraordinary level of collaboration between community groups (NGOs) and banks across the US. This collaboration is institutionalized through CRA agreements. These are pledges signed by a community organization(s)and a bank outlining a multi-year program of lending, investments,and/or services. The amount of cash benefit agreed by the banks under CRA agreements has increased by a factor of ten since 1991 and not stands at $1.1 billion. The credit needs covered by CRA agreements include: housing, economic development, consumer loans, farm loans, building community capacity, outreach and marketing in the community, financial support for NGOs and branch and banking services. Housing loans make up nearly 46% of CRA agreement activity. Community development (33%) and Small business (16%) make up the bulk of other activity. As a result of CRA agreements the number of NGOs funded by banks to serve low wealth populations has grown exponentially. Indeed many traditionally poor neighbourhoods have seen such rapid recovery that in some instances they have attracted unwanted gentrification. Most importantly lending to low and moderate income people encouraged by the CRA has proven to be safe, sound and profitable. CRA has succeeded in directing the market towards an activity that they would have been doing anyway if the market mechanisms had been working better. In 2004 members of the UK’s Community Development Finance Association visited Chicago and had the opportunity to meet and interview officials from banks, the federal regulators and from communities. The results were surprising. The banks and the regulators were enthusiastic supporters of the CRA. They emphasised that the level of public and private partnership that we had seen did not happen before the CRA reform of a decade earlier. This new partnership between people on the ground in the communities and the banks had been creative and useful to the banks in helping them to understand new underserved markets. The profit margins on this work may not be as good as corporate finance but it is steady business and surprisingly safe. Conclusion The United States is widely regarded by Europeans as having an ultra capitalistic economic and social model red in tooth and claw. There is a paradox about the way that a social innovation in this capitalistic system has led to so much private sector innovation at the interface between banks and the communities which they serve and from which they take deposits. The key to this innovation was the way that public disclosure of bank lending data empowered communities. They have won the argument with new tools often using geographic information systems and sophisticated data analysis. It is worth noting that the changed behaviour of the banks is not driven by direct market pressures. Customers do not choose their bank on the basis of its CRA performance. Instead it is the banks’ fear of bad reputation and their need to have high ratings so that they engage in mergers and acquisitions that drives their behaviour. The most important revelation was that underserved markets were profitable. CRA would not have been so successful if the banks had not been able to invest in the communities according to sound and safe banking principles. The next article will explore whether the model of bank regulation that CRA exemplifies is transferable to a European context. Is there a problem that needs addressing? Do we need to ask banks in Europe to disclose their bank lending? Is such an approach relevant in social Europe? And should regulation be pursued at the European or the National level?